Decoder: Futures
When futures traders buy grain, oil or other commodities, they're paying what they think those products will be worth in several weeks or months. How does the process work? Rico Gagliano explains in The Marketplace Decoder.
Traders signal offers in the S&P 500 stock index futures pit at the Chicago Board of Trade. (Scott Olson/Getty Images)
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TEXT OF STORY
TESS VIGELAND:
Earlier we mentioned OPEC is cutting oil production in an effort to boost prices. Well six months ago you could have counted on one hand the number of people predicting that a barrel of light crude would cost around 40 bucks. Back then, oil traders were paying well north of 100 bucks a barrel on the oil futures markets. And there's the rub.Those traders weren't actually buying barrels of oil and wheeling them home. They were paying what they thought a barrel of oil would cost at some point in the future. Which is why they're called futures.
Yes, it's confusing, but here to help us figure it all out is Marketplace's Rico Gagliano. With the latest instalment of The Marketplace Decoder.
Rico Gagliano: OK, let's jump right in with a definition. It comes from Jeff Carter: he's an independent speculator and a former director of the Chicago Mercantile Exchange.
Jeff Carter: A future is merely a contract where the buyer agrees to buy a commodity, and a seller agrees to sell a commodity, at a specified price sometime in the future!
He's laughing because, yes, this is a financial instrument, with a name that actually makes sense! I know, I know, incredible. But just to make sure you understand futures, let's dramatize the transaction, which we'll do, ironically, by taking a trip to -- the past.
Carter: Futures have been around forever. Chinese traded 'em back in 1100. Uh, rice futures.
At least there's some evidence they go back that far. So via the magic of radio, let's imagine what might've gone down in a Chinese rice paddy circa 1100.
Chinese rice farmer: Hello, I'm a Chinese rice farmer.
Gagliano: Hey. Nice paddy.
Farmer: Yeah -- it's pretty swank. But I'm worried, man.
Gagliano: Why's that, dude?
Farmer: 'Cause there's way too much rice on the market these days. When harvest rolls around, I'm just praying I can sell enough to cover expenses.
Gagliano: Tell you what. I will promise, right now, to buy half your rice once it's harvested. On that day I'll pay you two copper pieces a ton.
Farmer: Sweet! That'll cover my expenses, with money left over to take the wife to Vegas!
Gagliano: Vegas doesn't exist yet, but whatever! And you know what - I think rice is going to sell for more than two copper pieces. So I figure I'm locking in a super-cheap price!
Farmer: Hey, let's write this down in a contract!
Gagliano: Genius! And . . . scene.
So that's a futures contract. Farmer gets a guaranteed sale. Buyer locks in a potentially low price. Now, in today's futures markets, traders sell contracts for everything from rice to oil. They don't plan on ever actually touching those commodities. But by trading the contracts, they can gamble on where they think prices are headed. Kevin Kerr is editor of Global Commodities Alert.
Kevin Kerr: If you think it's going higher, you want to buy the futures. If you think that oil will go lower, then you can sell it. So you really have to decide which way you think it's going ahead of time, and then place your bet.
That can be risky -- just check out the wild swings in oil futures lately. Kerr says the government may start enforcing rules that could calm the market, though. Which I guess means regulation is the future of futures.
In Los Angeles, I'm Rico Gagliano for Marketplace.
Comments
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From Sacramento, CA, 02/20/2009
This edition of the Marketplace Decoder was actually my first experience with the feature and--believe it or not--sold me on the Marketplace program! I'm one of those listeners who's not very financial-term savvy, but I'm happy to have an opportunity to learn just a little at a time. The detailed explanation of the term "futures" may have seemed unnecessary to many, but I found it to be perfect. Not only did I laugh out loud when I heard the segment, but it gave me a very tangible illustration of the term--just a small foothold in the complex world of finance. I won't be quitting my day job anytime soon, but I look forward to learning more about finance and financial terms by listening to Marketplace and, especially, the Marketplace Decoder. Thanks for a job well done!
12/27/2008
Excellent presentation which is both hilarious as well as educational. Some one commented that it was very basic but I think it was exactly right content for the layman listeners who are not very financial term savvy. And regarding the name "Decoder". Whats wrong with it. The excerpt decodes the term "Futures" very effectively.
Good work.
12/18/2008
Excellent and funny at the same time, though I think your team glossed over what I think is the keyword and most disturbing part of this concept in modern America. "But by trading the contracts, they can gamble on where they think prices are headed" means just that, this sort of practice is GAMBLING, and while I'm not against it, I'm angry every time financial companies and lobbyists try to pretend it's not. Just admit it, regulate it like we regulate gambling, and things should settle down some...
From Atlanta, GA, 12/18/2008
you started off strong by pointing out that the nomenclature of futures trading actually makes sense. But you went steadily downhill from there. You should have assumed your audience is decently smart and immediately moved on from something that already makes sense. Instead you insisted on beating the dead horse and the whole story became about defining a term wich, as you pointed out initially, already makes sense because its name describes it. The world of futures contracts can be murky, and I was hoping this story would teach me something about strategies for when and how to use them. Its called Marketplace Decoder, not Marketplace Dictionary, and if it were the Marketplace Dictionary, it might be prudent to pick a word whose definition isn't self-xplanatory.
From Frederick, MD, 12/18/2008
I just wanted to say the rice paddy dramatization was awesome. It gave me a good laugh.
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